Growing Big While Staying Small: Starbucks Harvests International Growth Net Present Value (NPV) / MBA Resources

Introduction to Net Present Value (NPV) - What is Net Present Value (NPV) ? How it impacts financial decisions regarding project management?

NPV solution for Growing Big While Staying Small: Starbucks Harvests International Growth case study

At Oak Spring University, we provide corporate level professional Net Present Value (NPV) case study solution. Growing Big While Staying Small: Starbucks Harvests International Growth case study is a Harvard Business School (HBR) case study written by Richard Honack, Sachin Waikar. The Growing Big While Staying Small: Starbucks Harvests International Growth (referred as “Starbucks Starbucks's” from here on) case study provides evaluation & decision scenario in field of Organizational Development. It also touches upon business topics such as - Value proposition, Entrepreneurship.

The net present value (NPV) of an investment proposal is the present value of the proposal’s net cash flows less the proposal’s initial cash outflow. If a project’s NPV is greater than or equal to zero, the project should be accepted.

NPV = Present Value of Future Cash Flows LESS Project’s Initial Investment

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Case Description of Growing Big While Staying Small: Starbucks Harvests International Growth Case Study

By early 2009 Starbucks had nearly 17,000 stores worldwide, with about a third of these outside the United States. Despite multibillion-dollar annual revenues, the giant coffee retailer's yearly growth had declined by half, quarterly earnings had dropped as much as 97 percent, same-store sales were negative, and its stock price was languishing. Factors such as a global economic downturn and increasing competition in the specialty coffee market from large players such as McDonald's and Dunkin' Donuts had driven this decline, resulting in the closings of hundreds of domestic stores already, with many more planned. Founder Howard Schultz, who had recently returned as CEO, and his executive team were convinced that Starbucks's growth opportunities lay overseas, where the firm already had a strong foothold in markets like Japan and the United Kingdom and was preparing to open hundreds of new stores in a variety of locations. But recent international challenges, including the closing of most Australian stores due to sluggish sales, made clear that Starbucks had more to learn about bringing its value proposition-a combination of premium coffee, superior service, and a "coffeehouse experience"-to foreign soil. The key question was not whether Starbucks could transport its value proposition overseas, but how the value proposition's three elements would play in recently entered and new markets. And the stakes of making the right international moves rose with each U.S. store closure. Schultz and his team also faced a broader question, one that applied to both their U.S. and foreign stores: Could they "grow big and stay small," remaining a huge retailer that delivered both high-quality products and a consistently intimate and enjoyable experience to consumers worldwide? This case presents this challenge in the context of Starbucks's history, well-established value proposition, and domestic and international growth and vision.

Case Authors : Richard Honack, Sachin Waikar

Topic : Organizational Development

Related Areas : Entrepreneurship

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Calculating Net Present Value (NPV) at 6% for Growing Big While Staying Small: Starbucks Harvests International Growth Case Study

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 6 %	Discounted Cash Flows
Year 0	(10028190)	-10028190	-	-
Year 1	3471975	-6556215	3471975	0.9434	3275448
Year 2	3967365	-2588850	7439340	0.89	3530941
Year 3	3949038	1360188	11388378	0.8396	3315688
Year 4	3242574	4602762	14630952	0.7921	2568422
TOTAL			14630952		12690500

The Net Present Value at 6% discount rate is 2662310

In isolation the NPV number doesn't mean much but put in right context then it is one of the best method to evaluate project returns. In this article we will cover -

Different methods of capital budgeting

What is NPV & Formula of NPV,
How it is calculated,
How to use NPV number for project evaluation, and
Scenario Planning given risks and management priorities.

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Capital Budgeting Approaches

Methods of Capital Budgeting

There are four types of capital budgeting techniques that are widely used in the corporate world –

1. Internal Rate of Return
2. Net Present Value
3. Payback Period
4. Profitability Index

Apart from the Payback period method which is an additive method, rest of the methods are based on Discounted Cash Flow technique. Even though cash flow can be calculated based on the nature of the project, for the simplicity of the article we are assuming that all the expected cash flows are realized at the end of the year.

Discounted Cash Flow approaches provide a more objective basis for evaluating and selecting investment projects. They take into consideration both –

1. Magnitude of both incoming and outgoing cash flows – Projects can be capital intensive, time intensive, or both. Starbucks Starbucks's shareholders have preference for diversified projects investment rather than prospective high income from a single capital intensive project.
2. Timing of the expected cash flows – stockholders of Starbucks Starbucks's have higher preference for cash returns over 4-5 years rather than 10-15 years given the nature of the volatility in the industry.

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Formula and Steps to Calculate Net Present Value (NPV) of Growing Big While Staying Small: Starbucks Harvests International Growth

NPV = Net Cash In Flowt1 / (1+r)t1 + Net Cash In Flowt2 / (1+r)t2 + … Net Cash In Flowtn / (1+r)tn
Less Net Cash Out Flowt0 / (1+r)t0

Where t = time period, in this case year 1, year 2 and so on.
r = discount rate or return that could be earned using other safe proposition such as fixed deposit or treasury bond rate. Net Cash In Flow – What the firm will get each year.
Net Cash Out Flow – What the firm needs to invest initially in the project.

Step 1 – Understand the nature of the project and calculate cash flow for each year.
Step 2 – Discount those cash flow based on the discount rate.
Step 3 – Add all the discounted cash flow.
Step 4 – Selection of the project

Why Organizational Development Managers need to know Financial Tools such as Net Present Value (NPV)?

In our daily workplace we often come across people and colleagues who are just focused on their core competency and targets they have to deliver. For example marketing managers at Starbucks Starbucks's often design programs whose objective is to drive brand awareness and customer reach. But how that 30 point increase in brand awareness or 10 point increase in customer touch points will result into shareholders’ value is not specified.

To overcome such scenarios managers at Starbucks Starbucks's needs to not only know the financial aspect of project management but also needs to have tools to integrate them into part of the project development and monitoring plan.

Calculating Net Present Value (NPV) at 15%

After working through various assumptions we reached a conclusion that risk is far higher than 6%. In a reasonably stable industry with weak competition - 15% discount rate can be a good benchmark.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 15 %	Discounted Cash Flows
Year 0	(10028190)	-10028190	-	-
Year 1	3471975	-6556215	3471975	0.8696	3019109
Year 2	3967365	-2588850	7439340	0.7561	2999898
Year 3	3949038	1360188	11388378	0.6575	2596557
Year 4	3242574	4602762	14630952	0.5718	1853952
TOTAL					10469515

The Net NPV after 4 years is 441325

(10469515 - 10028190 )

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Calculating Net Present Value (NPV) at 20%

If the risk component is high in the industry then we should go for a higher hurdle rate / discount rate of 20%.

Years	Cash Flow	Net Cash Flow	Cumulative     Cash Flow	Discount Rate @ 20 %	Discounted Cash Flows
Year 0	(10028190)	-10028190	-	-
Year 1	3471975	-6556215	3471975	0.8333	2893313
Year 2	3967365	-2588850	7439340	0.6944	2755115
Year 3	3949038	1360188	11388378	0.5787	2285323
Year 4	3242574	4602762	14630952	0.4823	1563741
TOTAL					9497491

The Net NPV after 4 years is -530699

At 20% discount rate the NPV is negative (9497491 - 10028190 ) so ideally we can't select the project if macro and micro factors don't allow financial managers of Starbucks Starbucks's to discount cash flow at lower discount rates such as 15%.

Acceptance Criteria of a Project based on NPV

Simplest Approach – If the investment project of Starbucks Starbucks's has a NPV value higher than Zero then finance managers at Starbucks Starbucks's can ACCEPT the project, otherwise they can reject the project. This means that project will deliver higher returns over the period of time than any alternate investment strategy.

In theory if the required rate of return or discount rate is chosen correctly by finance managers at Starbucks Starbucks's, then the stock price of the Starbucks Starbucks's should change by same amount of the NPV. In real world we know that share price also reflects various other factors that can be related to both macro and micro environment.

In the same vein – accepting the project with zero NPV should result in stagnant share price. Finance managers use discount rates as a measure of risk components in the project execution process.

Sensitivity Analysis

Project selection is often a far more complex decision than just choosing it based on the NPV number. Finance managers at Starbucks Starbucks's should conduct a sensitivity analysis to better understand not only the inherent risk of the projects but also how those risks can be either factored in or mitigated during the project execution. Sensitivity analysis helps in –

Understanding of risks involved in the project.

What are the uncertainties surrounding the project Initial Cash Outlay (ICO’s). ICO’s often have several different components such as land, machinery, building, and other equipment.

What will be a multi year spillover effect of various taxation regulations.

What are the key aspects of the projects that need to be monitored, refined, and retuned for continuous delivery of projected cash flows.

What can impact the cash flow of the project.

Some of the assumptions while using the Discounted Cash Flow Methods –

Projects are assumed to be Mutually Exclusive – This is seldom the came in modern day giant organizations where projects are often inter-related and rejecting a project solely based on NPV can result in sunk cost from a related project.

Independent projects have independent cash flows – As explained in the marketing project – though the project may look independent but in reality it is not as the brand awareness project can be closely associated with the spending on sales promotions and product specific advertising.

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Negotiation Strategy of Growing Big While Staying Small: Starbucks Harvests International Growth

References & Further Readings

Richard Honack, Sachin Waikar (2018), "Growing Big While Staying Small: Starbucks Harvests International Growth Harvard Business Review Case Study. Published by HBR Publications.